Book Value VS. Market
Value: What's the Difference
TABLE OF CONTENTS
Book Value Vs.
Market Value
Book Value VS. Market
Value: An Overview
Valuing
a listed company is a complex task, and several different measures are used to
arrive at a fair valuation. While none of the methods is precise and each
presents a different version with varying results, investors use them in
combination to get a good understanding of how stocks have performed. Two most
commonly used quantitative measures for valuing a company are market value and
book value. This article compares the two popular factors, their differences,
and how they can be used in analyzing companies.
Book Value
The
book value literally means the value of a business according to its books
(accounts) that is reflected through its financial statements. Theoretically,
book value represents the total amount a company is worth if all its assets are
sold and all the liabilities are paid back. This is the amount that the
company’s creditors and investors can expect to receive if the company is
liquidated.
Book Value of Equity Per
Share (BVPS)
Book
Value Formula
Mathematically,
book value is calculated as the difference between a company's total assets and
total liabilities.
\text{Book
value of a company} = \text{Total assets} - \text{Total liabilities}Book value
of a company=Total assets−Total liabilities
For
example, if Company XYZ has total assets of $100 million and total liabilities
of $80 million, the book value of the company is $20 million. In a broad sense,
this means that if the company sold off its assets and paid down its
liabilities, the equity value or net worth of the business would be $20
million.
Total
assets include all kinds of assets, such as cash and short term investments,
total accounts receivable, inventories, net property, plant and equipment
(PP&E), investments and advances, intangible assets like goodwill, and
tangible assets. Total liabilities include items like short and long term debt
obligations, accounts payable, and deferred taxes.
Book Value Example
Deriving
the book value of a company is straightforward since companies report total
assets and total liabilities on their balance sheet on a quarterly and annual
basis. Additionally, the book value is also available as shareholders' equity
on the balance sheet. For example, technology leader Microsoft Corp.’s (MSFT)
balance sheet for the fiscal year ending June 2018 reports total assets of
$258.85 billion and total liabilities of $176.13 billion. It leads to a book
value of ($258.85 billion - $176.13 billion) $82.72 billion. This is the same
figure reported as shareholder's equity.
One
must note that if the company has a component of minority interest, that value
must be further reduced to arrive at the correct book value. Minority interest
is the ownership of less than 50 percent of a subsidiary's equity by an
investor or a company other than the parent company. For instance, retail giant
Walmart Inc. (WMT) had total assets of $204.52 billion and total liabilities of
$123.7 billion for the fiscal year ending January 2018, which gives its net
worth as $80.82 billion. Additionally, the company had accumulated minority
interest of $2.95 billion, which when reduced gives the net book value or
shareholder’s equity as $77.87 billion for Walmart during the given period.
Companies
with a lot of machinery inventory and equipment, or financial instruments and
assets tend to have large book values. In contrast, gaming companies,
consultancies, fashion designers, or trading firms may have little to no book
value because they mainly rely on human capital, which is a measure of the
economic value of an employee's skill set. When
book value is divided by the number of outstanding shares, we get the book
value per share (BVPS) which can be used to make a per share comparison.
Outstanding shares refer to a company's stock currently held by all its
shareholders, including share blocks held by institutional investors and
restricted shares.
Limitations of Book Value
One
of the major issues with book value is that the figure is reported quarterly or
annually. It is only after the reporting that an investor would know how the
company’s book value has changed over the months.
Book
value is an accounting item and is subject to adjustments (e.g., depreciation)
which may not be easy to understand and assess. If the company has been
depreciating its assets, one may need to check several years of financial
statements to understand its impact. Additionally, due to depreciation-linked
rules of accounting practices, a company may be forced to report a higher value
of its equipment though its value may have gone down.
Book
value may also not consider the realistic impact of claims on its assets, like
those for loans. The book valuation may be different than the real value if the
company is a bankruptcy candidate and has several liens against its assets.
Book
value is not very useful for businesses relying heavily on human capital.
Market Value
The
market value represents the value of a company according to the stock market.
While market value is a generic term that represents the price an asset would
get in the marketplace, it represents the market capitalization in the context
of companies. It is the aggregate market value of a company represented as a
dollar amount. Since it represents the “market” value of a company, it is
computed based on the current market price (CMP) of its shares.
Market Value Formula
Market
value—also known as market cap—is calculated by multiplying a company's
outstanding shares by its current market price.
\text{Market
cap of a company} = \text{Current market price (per share)} * \text{Total
number of outstanding shares}Market cap of a company=Current market price (per
share)∗Total
number of outstanding shares
If
Company XYZ is trading at $25 per share and has 1 million shares outstanding,
then the company's market value is $25 million. Market value is most often the
number analysts, newspapers, and investors refer to when they mention the value
of a company.
Since
the market price of shares changes throughout the day, the market cap of a
company also changes accordingly. Changes to the number of shares outstanding
are rare as that number changes only when a company pursues certain types of
corporate actions, due to which market cap changes are primarily attributed to
per share price changes.
Market Value Example
Continuing
the above-mentioned examples, the shares outstanding for Microsoft on June 29,
2018 (end of Microsoft’s fiscal year) were 7.794 billion, and the stock closed
at the price of $98.61 per share. The resulting market cap was (7.794 billion *
$98.61) $768.56 billion. This market value is more than nine times the book
value of the company ($82.72 billion) calculated in the earlier section.
Similarly,
Walmart had 3.01 billion shares outstanding and a closing price of $106.6 per
share as of January 31, 2018 (end of Walmart’s fiscal year). The firm's market
value was (3.01 billion * $106.6) $320.866 billion, which is more than four
times the book value of Walmart ($77.87 billion) calculated in the earlier
section.
It
is quite common to see the book value and market value differ significantly.
The difference is attributed to several factors, including the company's
operating model, its industrial sector, the nature of a company's assets and
liabilities, and the company's specific attributes.
Market Value Limitations
While
market cap represents the market perception of a company’s valuation, it may
not necessarily represent the true picture. It is common to see even mega-cap
and large-cap stocks moving 3 to 5 percent up or down during a day’s session. A
stock often gets overbought or oversold, and relying solely on market cap
valuations may not be the best method to assess a stock’s realistic potential.
Book Value and Market
Value Use
Most
publicly listed companies fulfill their capital needs through a combination of
debt and equity. Debt is raised by taking loans from banks and other financial
institutions or by floating interest-paying corporate bonds. Equity capital is
raised by listing the shares on the stock exchange through an initial public
offering (IPO) or through other measures, such as follow-on issues, rights
issues, and additional share sales. Debt capital requires payment of interest,
as well as repayment of loaned money to the creditors; however, equity capital
has no such obligation for the company as equity investors aim for dividend
income or capital gains emerging from fluctuations in the stock prices.
Creditors
who provide the necessary capital to the business are interested in the
company's asset value as they are more concerned about repayment. Book value is
used by creditors to determine how much capital to lend to the company since
assets are typically used as collateral or determine a company's ability to pay
back the loan over a given time. On
the other hand, investors and traders are more interested in timely buying or
selling of a stock at a fair price. Market value, when used in comparison with
other measures, including book value, provides a fair idea of whether the stock
is fairly valued, overvalued, or undervalued.
Comparing Book and Market
Value
Most
investors and traders use both values; there can be three different scenarios
while comparing the book value and market value.
Book
value greater than market value: If a company is trading at a market value
which is lower than its book value, it usually indicates that the market has
momentarily lost confidence in the company. It may be due to problems with the
business, loss of important business-related lawsuits, or chances of financial
anomalies. In other words, the market doesn't believe that the company is worth
the value on its books or that there are enough assets to generate future
profits and cash flows. Value investors often like to seek out companies in
this category in hopes that the market perception turns out to be incorrect in
the future. In this scenario, the market is giving investors an opportunity to
buy a company for less than its stated net worth, meaning the stock price is
lower than the company's book value. However, there is no guarantee that the
price will rise in the future.
A
market value greater than book value: When the market value exceeds the book
value, the stock market is assigning a higher value to the company due to the
potential of it and its assets' earnings power. It indicates that investors
believe the company has excellent future prospects for growth, expansion, and
increased profits that will eventually raise the book value of the company. They
may also believe the value of the company is higher than what the current book
value calculation shows. Consistently, profitable companies typically have
market values greater than book values, and most of the companies in the top
indexes meet this criterion, as seen from the examples of Microsoft and Walmart
mentioned above. Growth investors may find such companies promising. However,
it may also indicate overvalued or overbought stocks trading at a high price.
Book value equals market
value:
The
market sees no compelling reason to believe the company's assets are better or
worse than what is stated on the balance sheet. A
popular ratio that is used to compare market and book values is the
price-to-book (P/B) ratio, which is calculated as the price per share divided
by the book value per share. For example, a company has a P/B of 1, meaning
that the book value and market value are equal. The next day, the market price
drops and the P/B ratio becomes less than 1, meaning the market value is less
than the book value (undervalued). The following day the market price zooms
higher and creates a P/B ratio greater than 1, meaning market value now exceeds
book value (overvalued). Since prices change every second, it is possible to
track and spot stocks which move from a P/B ratio of less than one to more than
one and time the trades to maximize the profits.
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